Warren Buffett has said in interviews and in writings that Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B) would be an enthusiastic buyer of its own stock at a price of 1.2 times book value. At that price, Buffett believes, buybacks would be a good use of the company's cash.
Alas, Berkshire rarely trades that low, in part because of this implicit "Buffett put." Shareholders know that the buyback machine will ramp up if Berkshire stock trades down through the threshold. He defended pretty strongly his promise to buy back stock below 1.2 times book at the 2016 annual meeting.
One might think that with so much cash on hand (about $96 billion at the end of the last quarter), Berkshire might be willing to pay a higher multiple of book value to repurchase stock. But it is precisely because cash is building up that it seems unlikely that Buffett will move up to a higher multiple, perhaps 1.3 times book value.
Berkshire's coin jar is bursting at the brim with more than $96 billion of cash. Image source: Getty Images.
How to think about Berkshire's book value
A substantial portion of Berkshire's book value can be attributed to the cash it holds. For simplicity, we can evaluate it on the basis of Berkshire's Class A shares.
|
Balance Sheet Accounts per Berkshire Class A Share | |
|---|---|
|
Assets |
$654,451 |
|
Liabilities |
$358,171 |
|
Shareholders' equity |
$180,172 |
|
Cash |
$58,661 |
Data source: Berkshire SEC filings.
To get to a valuation of 1.2 times book value, one would have to value all of Berkshire's assets at approximately 1.09 times their accounting value. Of course, some assets are actually worth more than their carrying value. As Buffett frequently writes, GEICO has a value that vastly exceeds its value on the balance sheet. Likewise, Berkshire carries its investment in Kraft Heinz at far less than its market value. All these things add up.
On the other hand, some assets it holds aren't worth a premium to their accounting value. A dollar bill Berkshire holds is obviously not worth $1.09. Though Buffett may speak of Berkshire's valuation in terms of a simplistic multiple of book value, his ultimate goal is to correctly value the company based on its underlying asset value and its forward earnings power.
The last time Buffett increased the buyback threshold
Buffett increased his buyback level from 1.1 times book value to 1.2 times book value in December 2011, the last time Berkshire bought back its own stock.
At the time, Berkshire was smaller, but the proportions of assets, liabilities, and equity per share were very similar. At the end of the third quarter of 2011, the 1.2 book value multiple valued Berkshire's assets at $1.09 for every $1.00 of accounting value. There is little difference between these figures and the most recent ones.
What has changed since 2011, though, is the makeup of Berkshire Hathaway's balance sheet. Cash has grown faster than virtually every other asset. Berkshire's cash pile in 2011 was equal to 9% of its assets and 20% of its equity. Cash now stands at 15% of assets and 33% of the company's equity. Its stakes in publicly traded companies have also grown quickly, and are just as undeserving in terms of multiple of book value as its cash is.
Should cash continue to pile up, Berkshire will need to find ways to deploy it to generate a return and thus eliminate the cash drag on its earnings power. But increasing the multiple of book value that Berkshire is willing to pay seems unlikely, given that increasing levels of cash should theoretically reduce, not increase, Berkshire's price-to-book value multiple.
